Advisory Opinion 95-2

This staff advisory opinion is issued in response to your request dated February 6, 1995, for our views concerning the applicability of the Federal Trade Commission's Franchise Rule, 16 C.F.R. Part 436, to your company's business arrangement.

I. Introduction

Your company offers numerous services to homeowners, such as lawn care, pool maintenance, pest control, and carpet cleaning. The actual work is performed by professional, independent service providers. These service providers have been, and will continue to be, in business for themselves. Further, they are licensed, bonded, and insured before they begin their relationship with your company. Your company licenses its name to the service providers only while they perform work for your company.

Your company provides no training to the service providers, but does impose what you refer to as certain "procedural requirements." Service providers must: (1) respond to all referrals within a certain time; (2) perform the requested work to the homeowner's satisfaction; and (3) adhere to certain customer service standards while performing work for the company.

Finally, you note that the service providers make no investment with your company. In a telephone conversation with Commission staff you stated further that the service provides do not remit any fees from the homeowners to your company. Rather, your company pays the service providers a pre-determined portion of the fees it collects directly from the homeowner-customers. You call this compensation arrangement a "volume discount."

You ask essentially three questions: (1) do the requirements set forth above constitute "significant control and assistance" within the meaning of the Franchise Rule; (2) does the volume discount paid to the service providers constitute a required "payment or fee" under the Franchise Rule; and (3) does this business arrangement constitute a franchise and, if so, does it qualify for the fractional franchise exemption.

You should know that, as a matter of policy, the Commission's Franchise Rule enforcement staff will not issue any staff opinion on the ultimate issue whether, under a specific set of facts, a business relationship is covered by the Franchise Rule. We will, however, provide general guidance on the Franchise Rule that you may wish to consider in determining whether your company's arrangement constitutes a franchise.

II. Definition of the Term "Franchise"

We begin our analysis by noting that the term "franchise" refers to a continuing commercial relationship. According to your letter, the service providers will respond to referrals from your company. In turn, your company will pay the service providers a discounted amount for any services rendered to the homeowner-customers. This arrangement benefits both parties and is ongoing. These facts are sufficient to constitute a continuing commercial relationship.

To be covered by the Franchise Rule, a business arrangement must also satisfy the three definitional elements of a "franchise"(1) set forth in the Rule: (1) the distribution of goods or services associated with the franchisor's trademark or trade name; (2) significant control of, or significant assistance to, the franchisee; and (3) a required payment of at least $500 within 6 months of signing an agreement. 16 C.F.R. § 436.2(a)(1)(i).

A. Trademark or Trade Name

As stated above, the service providers obtain a limited license to use your company's tradename when performing work for your company. This is sufficient to satisfy the first definitional element.

B. Significant Control and Assistance

To be covered under the Franchise Rule, a company must also provide significant controls or assistance. In the Final Interpretive Guides to the Franchise Rule, the Commission stated that the term "significant" relates to:

the degree to which the franchisee is dependent upon the franchisor's superior business expertise -- an expertise made available to the franchisee by virtue of its association with the franchisor. The franchisee, in order to reduce its business risks or enhance its chances for business success, relies upon the availability of such expertise to avoid business mistakes that it otherwise might make.

44 Fed. Reg. 44965, 49967 (August 24, 1979).

Further, to be deemed "significant," the franchisor's controls and assistance must relate to the franchisee's entire method of operation. 16 C.F.R. §§ 436.1(a)(1)(i)(B)(1) and (2). Control and assistance relating to the franchisee's business organization, management, marketing plan, or business affairs, for example, will generally be deemed significant. On the other hand, controls or assistance relating to a small part of the franchisee's business ordinarily will not be deemed significant. See 44 Fed. Reg. at 49967.

In your letter, you state that the service providers are professional, independent businesspersons, who are also in business for themselves. You also state that the company does not provide training. The only controls imposed are that service providers respond timely to all referrals, perform work to the homeowner's satisfaction, and adhere to typical customers service standards, such as being polite, being punctual, and refraining from alcohol or drugs.

While it appears that the service providers are not dependent upon your company's expertise in order to perform the underlying homecare services, the question remains, however, whether such service providers are dependent upon your company for marketing assistance or to gain access to a customer base. Indeed, your letter suggests that the service providers are given referrals from your company. Without more information, however we cannot determine the extent to which a service provider's success is in fact dependent upon your company's access to a customer base, and perhaps other assistance, such as marketing and advertising.

C. Minimum Payment

As noted above, the third required element for Franchise Rule coverage is the payment of at least $500 within the first six months. In promulgating the Franchise Rule, the Commission included the "minimum payment" requirement, because it recognized that the Rule should focus upon those franchisees who have made a personally significant monetary investment. As stated in the Statement of Basis and Purpose accompanying the Franchise Rule:

Implicit in the concept of franchising, as viewed by the Commission, is the assumption of financial risk by a franchisee in entering into a franchise relationship. Indeed, it is essential that the prospective franchisee be given material information about the franchise offering in order to permit him to evaluate the risk that he is taking. Where a franchisee makes no significant investment in the franchise business, he assumes only a limited risk, and the protection of the rule is inappropriate.

43 Fed. Reg. 59614, 59704 (December 21, 1978).

You state that the service providers will pay no license fee or make any other investment. Further, the service providers will be paid directly by your company, based upon an agreed upon portion of the fees charged the homeowner-customers. The service providers, therefore, are essentially subcontractors. Under these facts, it does not appear that the service providers make any "required payment" to your company.

III. The Fractional Franchise Exemption

Finally, you ask whether this business arrangement qualifies for the fractional franchise exemption. The fractional franchise exemption is one of four exemptions provided by the Franchise Rule. See 16 C.F.R. § 436.2(d). The exemption is available to a company offering a business relationship that meets each of the three elements for Rule coverage if it can prove the following two conditions are met: (1) the franchisee with whom it enters a relationship has been "in the business represented by the franchise more than 2 years;" and (2) the "sales arising from the relationship . . . represent no more than 20 percent of the sales in dollar volume of the franchisee." Id. at § 436.2(h).(2)

Assuming, arguendo, that your company's business arrangement satisfies the three definitional elements of a franchise, it is possible that if may qualify for the fractional franchise exemption. We note, however, that it is the franchisor's obligation to establish that it qualifies for an exemption. While it is plausible that professional service providers might be in the same business for more than 2 years, you provide no evidence of that in your request letter. Similarly, you have submitted no information from which we can draw any inference about the sales levels service providers might attain by affiliating with your company. For these reasons, we cannot conclude that your company qualifies for the fractional franchise exemption.

IV. Conclusion

Based upon the information you have provided it appears that the service providers do not make a required payment to your company. Accordingly, your company does not appear to satisfy all three definitional elements of a "franchise" set out above. Finally, we do not have sufficient information to determine whether your company would qualify for the Franchise Rule's fractional franchise exemption.

Please be advised that our opinion is based on all the information furnished in the request. This opinion applies only to your company and to the extent that actual company practices conform to the material submitted for review. Please be advised further that the views expressed in this letter are those of the FTC staff. They have not been reviewed, approved, or adopted by the Commission, and they are not binding upon the Commission. However, they do reflect the opinions of the staff members charged with enforcement of the Franchise Rule.

Date: February 14, 1995
Franchise Rule Staff

(1)Another type of continuing commercial relationship covered by the Franchise Rule is the business opportunity venture. See 16 C.F.R. § 436.2(a)(1)(ii). Unlike a franchise, a business opportunity venture does not necessarily involve the use of the promoters' trademark or trade name. The most common types of business opportunity ventures are rack displays and vending machines routes.

(2)See Informal Advisory Opinions 94-8; 94-4; 93-5.

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